Europe's Looking Remarkably Resilient These Days

Europe’s economy has so often been the bearer of bad news of late that it seems almost a given that troublesome external trends would spell trouble for the continent. It would be easy to assume, then, that slowing Chinese growth and moderating global industrial activity might threaten the fragile European recovery. But that assumption would be wrong: Remarkably, Europe appears to be charting its own course of resiliency in 2014.

The threats are not insignificant. First, China, which buys 7 percent of Europe’s exported goods, announced last week that its economy grew 7.4 percent in the first quarter, the slowest pace in a year and a half. The figure was slightly better than expected, but foreign direct investment, imports and exports all fell in the month of March, and property sales dropped in the first quarter. Second, global industrial production appears to be slowing. Credit Suisse’s Basic Metals Index, which tracks the chemicals, energy, materials, paper and transportation sectors, fell in March for the third consecutive month and posted a three-month average of -0.81, the lowest level since 2010. Credit Suisse maintains a “cautious” outlook on short-term industrial production and the bank recently lowered its 2014 global GDP forecast to 3.3 percent from 3.7 percent as a result.

But Europe is forging ahead, however tentatively. Industrial production in the euro zone grew an encouraging 1.7 percent in February compared with a year earlier. The European Union’s Economic Sentiment Indicator rose to 102.4 in March, its highest level since 2011, driven “by markedly more confident consumers,” according to an E.U. report. And Markit Economics’ purchasing managers’ index had its largest quarterly gain in the three months ended March since 2011. Trends like these have Credit Suisse maintaining its forecast for slow-but-steady European growth of more than 1 percent this year.

So how has the euro zone insulated itself? While it trades extensively with China, much of that exposure is made up of intermediate goods assembled there to satisfy demand elsewhere. It’s also important to note that Europe’s deep recession in 2011 and 2012 was largely separate from global trends: domestic demand fell sharply while it rose in the U.S. and Japan. Similarly, the recovery is a “homemade affair,” as Credit Suisse puts it. Domestic demand accounted for 0.6 percentage points of the 0.7 percent increase in euro area GDP between the first and final quarters of last year, a trend that is likely to continue, Credit Suisse analysts Christel Aranda-Hassel and Steven Bryce said in a report entitled “Tougher than the Rest.”

Europe is also acting alone in terms of manufacturing inventories. Unlike in the U.S., where inventories swelled in the second half of last year and are now declining, companies in Europe liquidated their stockpiles at the end of 2013, which put a damper on growth at the time. The private sector was acting cautiously as it emerged from the recession, waiting to boost production until demand improved. The upside of that caution is that firms are now rebuilding their inventories, which Credit Suisse expects will further bolster industrial production.

Of course, some risks to the recovery still remain. Strong investment in the fourth quarter of last year was partly a one-off phenomenon driven by policy. New legislation on vehicle emissions that went into effect at the end of 2013, for example, encouraged companies to stock up on purchases of commercial vehicles in December. As a result, transport equipment accounted for about 80 basis points of the 1.1 percent investment growth posted in the fourth quarter, according to Credit Suisse. The slowing of those purchases in the first quarter could push investment growth back down by 70 basis points in the first quarter.

All that said, improving economic sentiment should boost corporate and consumer spending going forward, Credit Suisse says. And the improvement has breadth, both in in Europe’s largest economy and smaller southern economies that were hit hard in the recession. Germany’s central bank has said it expects strong growth in the first quarter, while Spain’s central bank estimates that economy will grow 1.2 percent this year. While the rest of the world is facing a slowdown in cyclical momentum, Europe, say Aranda-Hassel and Bryce, looks “resilient.” That’s the first time we’ve heard that in some time.